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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 10-Q
[Mark One]
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003
|_| TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to __________
Commission File Number: 0-25509
First Federal Bankshares,Inc.
(Exact name of registrant as specified in its charter)
Delaware 42-1485449
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
329 Pierce Street, Sioux City, Iowa 51101
(Address of principal executive offices)
Registrant's telephone number, including area code 712-277-0200
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed
since last report
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the Registrant is an accelerated filer. Yes |_|
No |X|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at February 11, 2004
----- --------------------------------
(Common Stock, $.01 par value) 3,781,900
FIRST FEDERAL BANKSHARES, INC.
INDEX
Page
Part I. Financial Information
Item 1. Financial Statements of First Federal
Bankshares, Inc. and Subsidiaries (Unaudited) 1
Condensed Consolidated Balance Sheets
at December 31, 2003 and June 30, 2003 1
Condensed Consolidated Statements of Operations
for the three- and six-month periods ended
December 31, 2003 and 2002 2
Condensed Consolidated Statements of Changes in
Stockholders' Equity for the six-month periods
ended December 31, 2003 and 2002 3
Condensed Consolidated Statements of Comprehensive
Income for the three- and six-month periods ended
December 31, 2003 and 2002 4
Condensed Consolidated Statements of Cash Flows
for the six-month periods ended
December 31, 2003 and 2002 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 21
Item 4. Controls and Procedures 21
Part II. Other Information 22
Item 1. Legal Proceedings 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 6. Exhibits and Reports on Form 8-K 23
Signatures 24
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FIRST FEDERAL BANKSHARES, INC and SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
December 31, June 30,
2003 2003
------------- -------------
Assets
Cash and due from banks $ 24,215,752 $ 34,006,405
Interest-bearing deposits in other financial institutions 281,721 280,548
------------- -------------
Cash and cash equivalents 24,497,473 34,286,953
------------- -------------
Securities available-for-sale, at fair value (amortized
cost of $61,662,126 and $77,392,727, respectively) 62,046,131 78,526,104
Securities held-to-maturity, at amortized cost
(fair value of $28,104,921 and $45,659,510, respectively) 27,044,521 44,505,464
Loans receivable 464,543,232 419,882,438
Less: Allowance for loan losses 4,862,531 4,615,285
------------- -------------
Net loans 459,680,701 415,267,153
------------- -------------
Office property and equipment, net 13,575,882 13,165,804
Federal Home Loan Bank ("FHLB") stock, at cost 6,402,100 5,707,300
Accrued interest receivable 2,533,430 2,488,460
Deferred tax asset 793,000 514,000
Goodwill (note 5) 18,523,607 18,523,607
Other assets 19,547,983 14,894,532
------------- -------------
Total assets $ 634,644,828 $ 627,879,377
============= =============
Liabilities
Deposits $ 440,223,470 $ 448,944,039
Advances from FHLB and other borrowings 118,149,860 102,386,888
Advance payments by borrowers for taxes and insurance 1,295,120 1,458,955
Accrued taxes on income -- 346,167
Accrued interest payable 1,345,743 1,795,348
Accrued expenses and other liabilities 2,895,447 3,286,615
------------- -------------
Total liabilities 563,909,640 558,218,012
------------- -------------
Stockholders' equity
Common stock, $.01 par value, 12,000,000 shares authorized;
4,919,257 and 4,896,857 shares issued at
December 31, 2003 and June 30, 2003, respectively 49,193 48,969
Additional paid-in capital 36,819,436 36,537,133
Retained earnings, substantially restricted 50,232,784 47,900,781
Treasury stock, at cost, 1,148,990 and 1,088,466 shares at
December 31, 2003 and June 30, 2003, respectively (15,449,468) (14,264,674)
Accumulated other comprehensive income 240,005 710,378
Unearned Employee Stock Ownership Plan ("ESOP") shares (1,115,440) (1,185,700)
Unearned Recognition and Retention Plan ("RRP") shares (41,322) (85,522)
------------- -------------
Total stockholders' equity 70,735,188 69,661,365
------------- -------------
Total liabilities and stockholders' equity $ 634,644,828 $ 627,879,377
============= =============
See notes to condensed consolidated financial statements.
-1-
FIRST FEDERAL BANKSHARES, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
Three months Six months
ended December 31, ended December 31,
2003 2002 2003 2002
----------------------------------------------------------------
Interest income:
Loans receivable $ 6,758,534 $7,639,266 $ 13,624,840 $15,387,428
Investment securities 999,894 1,499,541 2,090,660 3,234,000
Other interest-earning assets 5,726 6,718 10,647 10,948
----------------------------------------------------------------
Total interest income 7,764,154 9,145,525 15,726,147 18,632,376
----------------------------------------------------------------
Interest expense:
Deposits 1,963,800 2,907,029 4,036,781 6,187,955
Advances from FHLB and other borrowings 1,263,305 1,274,356 2,545,243 2,584,506
----------------------------------------------------------------
Total interest expense 3,227,105 4,181,385 6,582,024 8,772,461
----------------------------------------------------------------
Net interest income 4,537,049 4,964,140 9,144,123 9,859,915
Provision for losses on loans 100,000 400,000 625,000 1,230,000
----------------------------------------------------------------
Net interest income after provision for losses on loans 4,437,049 4,564,140 8,519,123 8,629,915
----------------------------------------------------------------
Noninterest income:
Fees and service charges 1,250,180 1,369,608 2,642,705 2,540,436
Gain on sale of loans held for sale 87,544 167,006 253,899 323,550
(Loss) gain on sale of real estate owned and
held for development (18,744) 25,852 (18,744) 48,240
Net (loss) gain on sale of securities (32,533) 37,500 (64,797) 37,500
Net gain on sale of office property and equipment 34,324 969 33,418 969
Real estate-related activities 326,989 395,577 688,664 723,015
Other income 403,014 468,062 863,028 877,940
----------------------------------------------------------------
Total noninterest income 2,050,774 2,464,574 4,398,173 4,551,650
----------------------------------------------------------------
Noninterest expense:
Compensation and benefits (note 7) 2,571,997 2,564,390 4,895,056 4,953,150
Office property and equipment 629,818 658,374 1,235,081 1,297,673
Data processing expense 102,920 79,157 197,387 154,118
Advertising 87,757 146,631 200,002 236,220
Other expense 1,008,356 1,240,406 1,977,511 2,422,899
----------------------------------------------------------------
Total noninterest expense 4,400,848 4,688,958 8,505,037 9,064,060
----------------------------------------------------------------
Earnings before income taxes 2,086,975 2,339,756 4,412,259 4,117,505
Income taxes 673,000 803,000 1,460,000 1,393,000
----------------------------------------------------------------
Net earnings $ 1,413,975 $1,536,756 $ 2,952,259 $ 2,724,505
================================================================
Earnings per share:
Basic earnings per share $ 0.39 $ 0.39 $ 0.81 $ 0.68
================================================================
Diluted earnings per share $ 0.38 $ 0.38 $ 0.79 $ 0.67
================================================================
Dividends declared per share $ 0.09 $ 0.08 $ 0.17 $ 0.16
================================================================
See notes to condensed consolidated financial statements.
-2-
FIRST FEDERAL BANKSHARES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS
OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)
Six months ended December 31,
2003 2002
---------------------------------
Capital Stock
Beginning of year balance $ 48,969 $ 48,711
Stock options exercised 224 171
- -------------------------------------------------------------------------------------------------------------
End of period balance 49,193 48,882
- -------------------------------------------------------------------------------------------------------------
Additional paid-in capital
Beginning of year balance 36,537,133 36,247,480
Stock options exercised 207,207 127,042
RRP (forfeited) awarded, net (7,000) 9,050
Stock appreciation of allocated ESOP shares 82,096 28,136
- -------------------------------------------------------------------------------------------------------------
End of period balance 36,819,436 36,411,708
- -------------------------------------------------------------------------------------------------------------
Retained earnings, substantially restricted
Beginning of year balance 47,900,781 43,542,299
Net earnings 2,952,259 2,724,505
Dividends paid on common stock (620,256) (640,784)
- -------------------------------------------------------------------------------------------------------------
End of period balance 50,232,784 45,626,020
- -------------------------------------------------------------------------------------------------------------
Treasury stock, at cost
Beginning of year balance (14,264,674) (7,577,646)
RRP (forfeited) awarded, net (25,200) (1,800)
Treasury stock purchased (1,159,594) (2,700,153)
- -------------------------------------------------------------------------------------------------------------
End of period balance (15,449,468) (10,279,599)
- -------------------------------------------------------------------------------------------------------------
Accumulated other comprehensive income
Beginning of year balance 710,378 490,458
Net change in unrealized gains on securities available-for-sale,
net of tax expense (511,001) 251,828
Less: reclassification adjustment for net realized (losses) gains
included in net income, net of tax expense (40,628) 23,513
- -------------------------------------------------------------------------------------------------------------
End of period balance 240,005 718,773
- -------------------------------------------------------------------------------------------------------------
Unearned ESOP shares
Beginning of year balance (1,185,700) (1,330,000)
ESOP shares allocated 70,260 73,120
- -------------------------------------------------------------------------------------------------------------
End of period balance (1,115,440) (1,256,880)
- -------------------------------------------------------------------------------------------------------------
Unearned recognition and retention plan shares
Beginning of year balance (85,522) (158,507)
RRP forfeited (awarded), net 14,981 2,350
Amortization of RRP expense 29,219 33,072
- -------------------------------------------------------------------------------------------------------------
End of period balance (41,322) (123,085)
- -------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------
Total stockholders' equity $ 70,735,188 $ 71,145,819
=============================================================================================================
See notes to condensed consolidated financial statements.
-3-
FIRST FEDERAL BANKSHARES, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS
OF COMPREHENSIVE INCOME (Unaudited)
Three Months Ended Six months ended
December 31, December 31,
2003 2002 2003 2002
---- ---- ---- ----
Net earnings $ 1,413,975 $ 1,536,756 $ 2,952,259 $2,724,505
Other comprehensive income (loss):
Unrealized holding (losses) gains arising during
the period, net of tax (66,238) (33,838) (511,001) 251,828
Less: reclassification adjustment for net realized
(losses) gains included in net income, net of tax expense (20,398) 23,513 (40,628) 23,513
----------------------------------------------------------
Other comprehensive (loss) income, net of tax (45,840) (57,351) (470,373) 228,315
----------------------------------------------------------
Comprehensive income $ 1,368,135 $ 1,479,405 $ 2,481,886 $2,952,820
==========================================================
See notes to condensed consolidated financial statements.
-4-
FIRST FEDERAL BANKSHARES, INC. and SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Six months ended December 31,
Cash flows from operating activities: 2003 2002
-------------------------------
Net earnings $ 2,952,259 $ 2,724,505
Adjustments to reconcile net earnings to net cash provided by operating activities:
Loans originated for sale to investors (22,484,000) (32,303,013)
Proceeds from sale of loans originated for sale 24,309,704 30,869,632
Provision for loan losses 625,000 1,230,000
Depreciation and amortization 693,891 991,199
Net gain on sale of loans (253,899) (323,550)
Net loss (gain) on sale of securities available-for-sale 64,797 (37,500)
Net loss (gain) on sale of real estate owned and held for development 18,744 (48,240)
Net gain on sale of office property and equipment (33,418) (969)
Net loan fees deferred 94,134 125,588
Amortization of premiums and discounts on loans and securities 152,930 108,729
(Increase) decrease in accrued interest receivable (44,970) 115,612
Increase in other assets (925,902) (2,115,309)
Decrease in accrued interest payable (449,605) (1,473,053)
(Decrease) increase in accrued expenses and other liabilities (391,169) 155,271
(Decrease) increase in accrued taxes on income (418,541) 210,253
-------------------------------
Net cash provided by operating activities 3,909,955 229,155
-------------------------------
Cash flows from investing activities:
Proceeds from maturities of securities held-to-maturity 17,405,243 7,771,241
Proceeds from sale of securities available-for-sale 13,585,515 15,067,500
Purchase of securities available-for-sale (8,209,971) (7,105,092)
Proceeds from maturities of securities available-for-sale 10,076,146 6,796,293
Purchase of bank owned life insurance (2,555,755) --
Purchase of Federal Home Loan Bank Stock (694,800) (669,500)
Loans purchased (20,029,000) (6,683,000)
(Increase) decrease in loans receivable (26,844,554) 6,840,827
Purchase of office property and equipment (906,195) (242,113)
Proceeds from sale of foreclosed real estate 41,526 178,726
Proceeds from sale of real estate held for development -- 54,298
Net expenditures on real estate held for development (873,739) (75,516)
-------------------------------
Net cash (used in) provided by investing activities (19,005,584) 21,933,664
-------------------------------
Cash flows from financing activities:
Decrease in deposits (8,720,569) (21,143,148)
Proceeds from FHLB advances and other borrowings 25,149,860 32,437,000
Repayment of FHLB advances and other borrowings (9,386,888) (20,057,484)
Net decrease in advances from borrowers for taxes and insurance (163,835) (297,962)
Issuance of common stock, net 207,431 127,213
Repurchase of common stock (1,159,594) (2,700,153)
Cash dividends paid (620,256) (640,784)
-------------------------------
Net cash provided by (used in) financing activities 5,306,149 (12,275,318)
-------------------------------
Net (decrease) increase in cash and cash equivalents (9,789,480) 9,887,501
Cash and cash equivalents at beginning of period 34,286,953 23,217,221
-------------------------------
Cash and cash equivalents at end of period $ 24,497,473 $ 33,104,722
===============================
Supplemental disclosures:
Cash paid for interest $ 7,031,629 $ 10,245,514
===============================
Cash paid for income taxes $ 1,878,539 $ 1,183,717
===============================
See notes to condensed consolidated financial statements.
-5-
FIRST FEDERAL BANKSHARES, INC. and SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. Basis of presentation
The condensed consolidated balance sheet information for June 30, 2003 was
derived from the audited Consolidated Balance Sheets of First Federal
Bankshares, Inc. (the "Company") at June 30, 2003. The condensed consolidated
financial statements as of and for the three months and six months ended
December 31, 2003 and 2002 are unaudited.
In the opinion of management of the Company these financial statements reflect
all adjustments, consisting only of normal recurring accruals necessary to
present fairly these condensed consolidated financial statements. The results of
operations for the interim periods are not necessarily indicative of results
that may be expected for an entire year. Certain information and footnote
disclosure normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of America have
been omitted.
The Company's critical accounting policies relate to the allowance for loan
losses and accounting for intangible assets. A description of the Company's
critical accounting policy related to intangible assets is summarized in Note 5
of these interim financial statements. With regard to the Company's critical
accounting policy related to the allowance for loan losses, the Company has
established a systematic method of periodically reviewing the credit quality of
the loan portfolio in order to establish an allowance for losses on loans. The
allowance for losses on loans is based on management's current judgments about
the credit quality of individual loans and segments of the loan portfolio. The
allowance for losses on loans is established through a provision for loan losses
based on management's evaluation of the risk inherent in the loan portfolio, and
considers all known internal and external factors that affect loan
collectibility as of the reporting date. Such evaluation, which includes a
review of all loans on which full collectability may not be reasonably assured,
considers among other matters, the estimated net realizable value or the fair
value of the underlying collateral, economic conditions, historical loan loss
experience, management's knowledge of inherent risks in the portfolio that are
probable and reasonably estimable and other factors that warrant recognition in
providing an appropriate loan loss allowance. This evaluation involves a high
degree of complexity and requires management to make subjective judgments that
often require assumptions or estimates about uncertain matters.
A summary of significant accounting policies followed by the Company is set
forth in Note 1 of the Company's 2003 Annual Report to Stockholders and is
incorporated herein by reference. The Company's critical accounting policies and
their application are periodically reviewed by the Audit Committee and the full
Board of Directors.
2. Organization
The Company is the holding company for First Federal Bank (the "Bank"). The
Company owns 100% of the Bank's common stock. Currently, the Company engages in
no other significant activities beyond its ownership of the Bank's common stock.
6
3. Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
4. Earnings per share
The following information was used in the computation of net earnings per common
share on both a basic and diluted basis for the periods presented.
Three months ended Six months ended
December 31, December 31,
2003 2002 2003 2002
---------- ---------- ---------- ----------
Basic earnings per share computation:
Net earnings $1,413,975 $1,536,756 $2,952,259 $2,724,505
Weighted average common shares
outstanding 3,637,478 3,946,926 3,638,798 3,978,070
---------- ---------- ---------- ----------
Basic earnings per share $ 0.39 $ 0.39 $ 0.81 $ 0.68
========== ========== ========== ==========
Diluted earnings per share computation:
Net earnings $1,413,975 $1,536,756 $2,952,259 $2,724,505
Weighted average common
shares outstanding - basic 3,637,478 3,946,926 3,638,798 3,978,070
Incremental option shares using
treasury stock method 116,069 82,382 115,491 84,968
---------- ---------- ---------- ----------
Weighted average diluted
shares outstanding 3,753,547 4,029,308 3,754,289 4,063,038
---------- ---------- ---------- ----------
Diluted earnings per share $ 0.38 $ 0.38 $ 0.79 $ 0.67
========== ========== ========== ==========
5. Goodwill and other intangible assets
In July 2001, the Financial Accounting Standards Board (the "FASB") issued
Statement No. 142 (SFAS 142), Goodwill and Other Intangible Assets. SFAS 142
requires that goodwill and intangible assets with indefinite useful lives no
longer be amortized, but instead tested for impairment at least annually in
accordance with the provisions of SFAS 142. SFAS 142 also requires that
intangible assets with definite useful lives be amortized over their respective
estimated useful lives to their estimated residual values, and reviewed for
impairment. The Company adopted the provisions of SFAS 142 effective July 1,
2001. In connection with SFAS 142's transitional goodwill impairment evaluation,
the Company performed an assessment and determined that goodwill was not
impaired as of the adoption date. As of the adoption date, the Company had
unamortized goodwill in the amount of $18,523,607. Effective July 1, 2001, the
amortization of goodwill was discontinued.
Additionally, during the quarter ended September 30, 2003, management reviewed
the assessment performed on adoption of SFAS 142 and determined that no material
events or circumstances had occurred since the original valuation which would
result in a significantly different conclusion if the valuation were updated for
the purpose of determining any potential goodwill
7
impairment. Consequently, the outstanding balance of goodwill has not changed
since the adoption of SFAS 142.
The gross carrying amount of intangible assets subject to amortization and the
associated accumulated amortization at December 31, 2003, is presented in the
table below. Amortization expense for intangible assets was $14,640 and
$108,621, respectively, for the three months ended December 31, 2003 and 2002
and $29,280 and $217,240, respectively, for the six months ended December 31,
2003 and 2002.
December 31, 2003
-----------------
Gross
carrying accumulated
amount amortization
---------- ------------
Intangible assets:
Core deposit premium $ 690,140 $ 452,950
Mortgage servicing rights 700,250 700,250
---------- ----------
Total $1,390,390 $1,153,200
========== ==========
Unamortized intangible assets $ 237,190
==========
Projections of amortization expense are based on existing asset balances and the
existing interest rate environment as of December 31, 2003. What the Company
actually experiences may be significantly different depending upon changes in
market interest rates and market conditions. The following table shows the
estimated future amortization expense for amortizing intangible assets:
Core deposit
premium
-------
Six months ended
June 30, 2004 $ 23,094
Years ended June 30,
2005 45,396
2006 44,604
2007 44,604
2008 44,604
2009 34,888
6. Dividends
On October 30, 2003 the Company declared a cash dividend on its common stock,
payable on November 28, 2003 to stockholders of record as of November 14, 2003,
equal to $0.09 per share. Dividends totaling $328,168 were paid to stockholders
on November 28, 2003.
On January 15, 2004 the Company declared a cash dividend on its common stock,
payable on February 27, 2004 to stockholders of record as of February 13, 2004
equal to $0.09 per share. The Company expects to pay approximately $340,400 to
stockholders on February 27, 2004.
8
7. Stock Options
At December 31, 2003, the Company had two stock-based employee compensation
plans, which are described more fully in Note 11 of the Company's 2003 Annual
Report to Stockholders.
The Company applies Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations in accounting for these
plans. Accordingly, no compensation cost has been recognized for its stock
options in the condensed consolidated financial statements. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS 123, Accounting for
Stock-based Compensation, to stock-based employee compensation.
Three months ended Six months ended
December 31, December 31,
2003 2002 2003 2002
--------------------------------- ---------------------------------
Net income, as reported $ 1,413,975 $ 1,536,756 $ 2,952,259 $ 2,724,505
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards,
net of related tax effects (18,697) (17,439) (37,080) (33,575)
------------- ------------- ------------- -------------
Pro forma net income $ 1,395,278 $ 1,519,317 $ 2,915,179 $ 2,690,930
============= ============= ============= =============
Earnings per share:
Basic - as reported $ 0.39 $ 0.39 $ 0.81 $ 0.68
Basic - pro forma $ 0.38 $ 0.38 $ 0.80 $ 0.68
============= ============= ============= =============
Diluted - as reported $ 0.38 $ 0.38 $ 0.79 $ 0.67
Diluted - pro forma $ 0.37 $ 0.38 $ 0.78 $ 0.66
============= ============= ============= =============
The fair value of each option grant has been estimated using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
grants in all periods presented: dividend yield of 3.41%; expected volatility of
22.76%; risk free interest rate of 6.29%; and expected life of 7.5 years.
8. Effect of New Accounting Standards
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities,
an interpretation of Accounting Research Bulletin No. 51. FIN 46 establishes
accounting guidance for consolidation by business enterprises of variable
interest entities ("VIE") that function to support the activities of the primary
beneficiary. Prior to the implementation of FIN 46, VIE were generally
consolidated by an enterprise when the enterprise had a controlling financial
interest through ownership of a majority of voting interest in the entity. The
provisions of FIN 46 were effective immediately for all arrangements entered
into after January 31, 2003. For existing VIE, the implementation date of FIN 46
is the first fiscal year or interim period beginning after June 15, 2003. The
Company's adoption of FIN 46 in
9
connection with its consolidated financial statements beginning July 1, 2003 was
not material as the Company does not presently have any VIE.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, ("SFAS 149"). SFAS 149 amends
Statement 133 for certain items. The Company adopted SFAS 149 on July 1, 2003
and such adoption did not have a material effect on its financial position or
results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS 150").
SFAS 150 established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or asset in some circumstances). The Company adopted SFAS 150 on
July 1, 2003 and such adoption did not have a material effect on its financial
position or results of operations.
In December 2003, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 03-3, Accounting for Certain Loans or Debt Securities
Acquired in a Transfer. The SOP applies to all loans acquired in a transfer,
including those acquired in the acquisition of a bank or a branch, and provides
that such loans be accounted for at fair value with no allowance for loan
losses, or other valuation allowance, permitted at the time of acquisition. The
difference between cash flows expected at the acquisition date and the
investment in the loan should be recognized as interest income over the life of
the loan. If contractually required payments for principal and interest are less
than expected cash flows, this amount should not be recognized as a yield
adjustment, a loss accrual, or a valuation allowance. The SOP is effective for
the Company's fiscal year beginning July 1, 2005. No significant impact is
expected on the consolidated financial statements at the time of adoption.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-looking statements
This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The Company intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Reform Act of
1995, and is including this statement for the purposes of these safe harbor
provisions. Forward-looking statements, which are based on certain assumptions
and describe future plans, strategies and expectations of the Company, are
generally identifiable by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project" or similar expressions. The Company's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors which could have a material adverse effect on the
Company's future activities and operating results include, but are not limited
to, changes in: interest rates, general economic conditions, legislative and
regulatory changes, U.S. monetary and fiscal policies, demand for products and
services, deposit flows, competition and accounting policies, principles and
guidelines. These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be placed on such
statements.
10
Financial condition
Total assets increased by $6.7 million, or 1.1%, to $634.6 million at December
31, 2003 from $627.9 million at June 30, 2003. Cash and cash equivalents
decreased by $9.8 million, or 28.6%, to $24.5 million at December 31, 2003 from
$34.3 million at June 30, 2003. The decrease in cash and cash equivalents was
largely due to a reduction in the level of compensating balances required at
correspondent banks as certain processing fees were shifted to a hard dollar
charge basis in the current fiscal year period. Proceeds from maturities and
sales of investment securities totaled $41.1 million for the six months ended
December 31, 2003 while purchases of investment securities for the same period
totaled $8.2 million. The net proceeds of $32.9 million from investment
securities activities partially funded an increase in loans receivable. Loans
receivable increased by $44.6 million, or 10.6%, to $464.5 million from $419.9
million at June 30, 2003. FHLB Stock increased by $695,000, or 12.2%, to $6.4
million at December 31, 2003 from $5.7 million at June 30, 2003 due to FHLB
stock purchase requirements related to outstanding advance balances.
Deposits decreased by $8.7 million, or 1.9%, to $440.2 million at December 31,
2003 from $448.9 million at June 30, 2003. The Company is generally not a market
rate leader for term deposits. In response to historically low market interest
rates, deposit customers have withdrawn funds from matured time deposits and
transferred those funds to more liquid accounts. The Company offers premium
rates to customers with multiple relationships in order to retain existing
deposits and attract new customers. Periodically, the Company offers premium
rates on select products in order to generate and retain deposits and to meet
certain asset/liability management objectives. Offsetting the decrease in the
balance of deposits was an increase in FHLB advances as the Company took down
fixed-rate fixed-term advances at generally lower rates than comparable-term
retail certificates of deposit. FHLB advances and other borrowings increased by
$15.7 million, or 15.4%, to $118.1 million at December 31, 2003 from $102.4
million at June 30, 2003.
Total stockholders' equity increased by $1.0 million, or 1.5%, to $70.7 million
at December 31, 2003 from $69.7 million at June 30, 2003. The Company
repurchased 54,500 shares of its common stock during the six months ended
December 31, 2003 at a cost of $1.2 million. A repurchase program announced in
August 2003 authorizes additional repurchases of up to 367,000 shares of the
Company's common stock, subject to market conditions and other factors. The
Company's management believes that stock repurchases are an appropriate
deployment of a portion of the Company's capital that enhances shareholder value
when the Company's common stock is repurchased at an appropriate price. With
capital levels in excess of regulatory requirements, as demonstrated in the
capital table included later in this report, and a basic core surplus of liquid
assets in excess of short term liabilities that totals $47.8 million, or 7.71%,
at December 31, 2003, the Company believes it can implement these repurchase
programs without adversely affecting its capital or liquidity positions or its
ability to pay future dividends. In addition, stock repurchase programs may
reduce price volatility and enhance the liquidity of the Company's common stock,
which is generally advantageous for shareholders.
Earnings totaled $1.4 million and $3.0 million, respectively, for the three
months and six months ended December 31, 2003. Excluding dividends on
unallocated Employee Stock Ownership Plan ("ESOP") shares, dividends declared
during the six months ended December 31, 2003 totaled $620,256.
11
Asset quality
Non-performing assets totaled $9.9 million, or 1.57% of total assets at December
31, 2003 and $5.1 million, or 0.81% of total assets at June 30, 2003. The
increase in non-performing assets was primarily due to an increase in the
balance of non-performing loans. Non-performing loans increased to $9.3 million
at December 31, 2003 from $4.7 million at June 30, 2003, representing 2.00% and
1.13%, respectively, of total loans at those dates. The increase in
non-performing loans was primarily the result of 3 commercial borrowers for
which delinquency exceeded 90 days at December 31, 2003, at which time the
Company stopped accruing interest income on the loans. Because these accounts
had already been identified as "classified" assets, there was no additional
impact on the required level of reserves or on the provision for loan losses. In
prior periods, these 3 accounts were not more than 90 days delinquent nor
accounted for on a non-accrual basis; therefore, the balances were not included
in the non-performing loan total. Management believes that these accounts are
well-secured and in the process of collection.
The allowance for loan losses is increased by the provision for loan losses
charged to operations and reduced by reversals and net charge-offs. Management
establishes the allowance for loan losses through a process that begins with
estimates of probable loss inherent in the portfolio based on various
statistical analyses. These analyses consider historical and projected default
rates and loss severities; internal risk ratings; and geographic, industry and
other environmental factors. In establishing the allowance for loan losses,
management also considers the Company's current business strategy and credit
processes, including compliance with established guidelines for credit limits,
credit approvals, loan underwriting criteria and loan workout procedures.
The policy of the Company is to segment the allowance to correspond to the
various types of loans in the loan portfolio according to the underlying
collateral, which corresponds to the respective levels of quantified and
inherent risk. The initial assessment takes into consideration non-performing
loans and the valuation of the collateral supporting each loan. Non-performing
loans are risk-rated generally on a case-by-case basis based on qualitative and
quantitative factors that include, but are not limited to, collateral type and
estimated value, financial statement analysis, specific economic factors, cash
flow analysis, delinquency history and loan workout situations and progress.
Based upon this analysis, a quantified risk factor is assigned to each
non-performing loan. This results in an allocation to the overall allowance for
the corresponding type and severity of each non-performing loan.
Performing loans are also reviewed by collateral type, with similar risk factors
being assigned. These risk factors take into consideration, among other matters,
the borrower's ability to pay and the Company's past loan loss experience with
each type of loan. The assigned risk factors result in allocations to the
allowance corresponding to the risk-rated portfolio of performing loans.
In order to determine its overall adequacy, the allowance for loan losses is
reviewed by management on a monthly basis. While management uses available
information to recognize losses on loans, future additions to the allowance may
be necessary, based on changes in economic and local market conditions beyond
management's control. In addition, various regulatory agencies
12
periodically review the Company's loan loss allowance as an integral part of the
examination process. Accordingly, the Company may be required to take certain
charge-offs and/or recognize additions to the allowance based on the judgment of
regulators as determined by information provided to them during their
examinations.
Based on relevant and presently available information, management believes that
the current allowance for loan losses is adequate. Following are tables
presenting (a) a summary of the allowance for loan losses and (b) non-performing
asset balances at December 31, 2003 and June 30, 2003.
(a) Summary of the allowance for loan losses
Three months ended Six months ended
December 31, December 31,
2003 2002 2003 2002
----------------------------- -----------------------------
Balance at beginning of period $ 4,908,453 $ 4,503,493 $ 4,615,285 $ 4,583,897
Provision for losses 100,000 400,000 625,000 1,230,000
Charge-offs (159,879) (404,901) (413,413) (1,372,135)
Recoveries 13,957 161,586 35,659 218,416
----------- ----------- ----------- -----------
Balance at end of period $ 4,862,531 $ 4,660,178 $ 4,862,531 $ 4,660,178
=========== =========== =========== ===========
(b) Non-performing assets
December 31, 2003 June 30, 2003
----------------- -------------
(Dollars in thousands)
Loans accounted for on a non-accrual basis:
One-to-four family $ 884 $ 335
Multi-family residential 2,132 2,426
Commercial real estate 2,667 628
Commercial business 1,599 --
Consumer 611 302
------ ------
Total $7,893 $3,691
------ ------
Loans 90 days past due and still accruing (1):
One-to-four family $1,132 $ 997
Multi-family residential -- --
Commercial real estate -- --
Commercial business 281 --
Consumer 7 --
------ ------
Total $1,420 $ 997
------ ------
Total non-performing loans $9,313 $4,688
------ ------
Other non-performing assets (2) $ 628 $ 412
------ ------
Total non-performing assets $9,941 $5,100
====== ======
Restructured loans not included in other
non-performing categories above (3) $1,245 $3,005
====== ======
Non-performing loans as a % of total loans 2.00% 1.13%
Non-performing loans as a % of total assets 1.47% 0.75%
Non-performing assets as a % of total assets 1.57% 0.81%
- ----------
(1) Delinquent FHA/VA guaranteed loans and delinquent loans with past due
interest that, in the opinion of management, is collectable, are not
placed on non- accrual.
(2) Represents the net book value of real property acquired through
foreclosure or deed in lieu of foreclosure and the net book value of
repossessed automobiles, boats and trailers. Other non-performing assets
are carried at the lower of cost or fair market value less estimated
disposal costs.
(3) Restructured loans have had amounts added to the principal balance and/or
the terms of the debt modified. Modification terms include payment
extensions, interest only payments and longer amortization periods, among
other possible concessions that would not normally be considered.
13
Capital
The Office of Thrift Supervision (the "OTS") requires that the Bank meet minimum
tangible, leverage (core) and risk-based capital requirements. As of December
31, 2003 the Bank was in compliance with all regulatory capital requirements.
Capital levels in excess of regulatory requirements enabled the Bank to pay
dividends to the Company in order to fund common stock repurchases. The Bank's
required, actual and excess capital levels as of December 31, 2003 were as
follows:
Excess of
Actual Over
Required % of Actual % of Regulatory
Amount Assets Amount Assets Requirement
------ ------ ------ ------ -----------
(Dollars in thousands)
Tangible Capital $ 9,200 1.5% $46,516 7.58% $37,316
Core Capital 18,400 3.0% 46,516 7.58% 28,116
Risk-based Capital 34,584 8.0% 51,378 11.88% 16,794
Liquidity
The Company is required by OTS regulation to maintain sufficient liquidity to
assure its safe and sound operation. Liquid assets include cash, certain time
deposits, banker's acceptances and specified United States government, state or
federal agency obligations. For the quarter ended December 31, 2003 the
Company's liquidity position was sufficient to enable the Company to deploy a
portion of such liquidity for stock repurchases. The Company adjusts its liquid
assets in order to meet funding needs for deposit outflows, payment of real
estate taxes from escrowed funds, when applicable, loan commitments and capital
strategies. The Company also adjusts liquidity as appropriate to meet its
asset/liability objectives.
Effect of new accounting standards
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 ("FIN 46"), Consolidation of Variable Interest Entities,
an interpretation of Accounting Research Bulletin No. 51. FIN 46 establishes
accounting guidance for consolidation by business enterprises of variable
interest entities ("VIE") that function to support the activities of the primary
beneficiary. Prior to the implementation of FIN 46, VIE were generally
consolidated by an enterprise when the enterprise had a controlling
14
financial interest through ownership of a majority of voting interest in the
entity. The provisions of FIN 46 were effective immediately for all arrangements
entered into after January 31, 2003. For existing VIE, the implementation date
of FIN 46 is the first fiscal year or interim period beginning after June 15,
2003. The Company's adoption of FIN 46 in connection with its consolidated
financial statements beginning July 1, 2003 was not material as the Company does
not presently have any VIE.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities, ("SFAS 149"). SFAS 149 amends
Statement 133 for certain items. The Company adopted SFAS 149 on July 1, 2003
and such adoption did not have a material effect on its financial position or
results of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS 150").
SFAS 150 established standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or asset in some circumstances). The Company adopted SFAS 150 on
July 1, 2003 and such adoption did not have a material effect on its financial
position or results of operations.
In December 2003, the Accounting Standards Executive Committee issued Statement
of Position ("SOP") 03-3, Accounting for Certain Loans or Debt Securities
Acquired in a Transfer. The SOP applies to all loans acquired in a transfer,
including those acquired in the acquisition of a bank or a branch, and provides
that such loans be accounted for at fair value with no allowance for loan
losses, or other valuation allowance, permitted at the time of acquisition. The
difference between cash flows expected at the acquisition date and the
investment in the loan should be recognized as interest income over the life of
the loan. If contractually required payments for principal and interest are less
than expected cash flows, this amount should not be recognized as a yield
adjustment, a loss accrual, or a valuation allowance. The SOP is effective for
the Company's fiscal year beginning July 1, 2005. No significant impact is
expected on the consolidated financial statements at the time of adoption.
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED December 31,
2003 and 2002
General. Net earnings for the three months ended December 31, 2003 decreased by
$123,000, or 8.0%, to $1.4 million, or $0.38 per diluted share, from $1.5
million, or $0.38 per diluted share, for the three months ended December 31,
2002.
Interest Income. Interest income decreased by $1.3 million, or 15.1%, to $7.8
million for the three months ended December 31, 2003 from $9.1 million for the
three months ended December 31, 2002. The average yield on interest-earning
assets decreased to 5.56% for the three months ended December 31, 2003 from
6.50% for the three months ended December 31, 2002, due to changes in the mix of
interest-earning assets and lower yields on all categories of interest-earning
assets in the continued low market interest rate environment. The average
balance of interest-earning assets was $560.4 million and $562.4 million,
respectively, for the three months ended December 31, 2003 and 2002.
15
Interest income on loans receivable decreased by $881,000, or 11.5%, to $6.8
million for the three months ended December 31, 2003 from $7.6 million for the
three months ended December 31, 2002. The decrease in interest income on loans
was primarily due to a decrease in the average yield on loans. The average yield
on loans receivable decreased by 143 basis points to 5.89% for the three months
ended December 31, 2003 from 7.32% for the three months ended December 31, 2002.
The decrease in the average yield on loans was due to refinancing activity and
to interest rate reductions for adjustable-rate loans in the generally lower
market interest rate environment during the current year period. Partially
offsetting the decrease in interest income due to lower yields was an increase
in the average balance of loans receivable. The average balance of loans
receivable increased by $39.5 million, or 9.5%, to $456.7 million for the three
months ended December 31, 2003 from $417.2 million for the three months ended
December 31, 2002. The increase in the average balance of loans receivable was
primarily funded by proceeds from the maturity and sale of investment
securities.
Interest income on investment securities decreased by $500,000, or 33.3%, to
$1.0 million for the three months ended December 31, 2003 from $1.5 million for
the three months ended December 31, 2002. The decrease in interest income on
investment securities was primarily due to a decrease in the average balance.
The average balance of investment securities decreased by $41.9 million, or
29.4% to $100.4 million for the three months ended December 31, 2003 from $142.3
million for the three months ended December 31, 2002. In addition, the average
tax-equivalent yield on investment securities decreased by 15 basis points to
4.21% for the three months ended December 31, 2003 from 4.36% for the three
months ended December 31, 2002 in the generally lower market interest rate
environment.
Interest Expense. Interest expense decreased by $954,000, or 22.8%, to $3.2
million for the three months ended December 31, 2003 from $4.2 million for the
three months ended December 31, 2002 primarily due to a decrease in interest on
deposits. Interest on deposits decreased by $943,000, or 32.5%, to $2.0 million
for the three months ended December 31, 2003 from $2.9 million for the three
months ended December 31, 2002. The average cost of deposits decreased by 78
basis points to 1.94% for the three months ended December 31, 2003 from 2.72%
for the three months ended December 31, 2002. The decrease in the average cost
of deposits was due to changes in the mix of deposit types and to the generally
lower market interest rate environment during the three months ended December
31, 2003. Also contributing to the decrease in interest on deposits was a
decrease in the average balance of deposits. The average balance of deposits
decreased by $26.4 million, or 6.2%, to $401.9 million for the three months
ended December 31, 2003 from $428.3 million for the three months ended December
31, 2002. In addition, the Company lowered rates on deposit products and
increased its use of wholesale funding from the FHLB with generally lower
interest costs than term deposits.
Interest on FHLB advances and other borrowings totaled $1.3 million for each of
the three month periods ended December 31, 2003 and 2002. The average cost of
borrowings decreased by 38 basis points to 4.35% for the three months ended
December 31, 2003 from 4.73% for the three months ended December 31, 2002.
Offsetting the decrease in the average cost of borrowings was an increase in the
average balance of borrowings. The average balance of borrowings increased by
$7.9 million, or 7.3%, to $115.6 million for the three months ended December 31,
2003 from $107.7 million for the three months ended December 31, 2002.
16
Net Interest Income. Net interest income before provision for losses on loans
decreased by $427,000, or 8.6%, to $4.5 million for the three months ended
December 31, 2003 from $5.0 million for the three months ended December 31, 2002
primarily due to a decrease in the Company's net interest margin. The Company's
net interest margin decreased by 27 basis points to 3.23% for the three months
ended December 31, 2003 from 3.50% for the three months ended December 31, 2002.
Provision for Losses on Loans. Provision for losses on loans totaled $100,000
for the three months ended December 31, 2003 and $400,000 for the three months
ended December 31, 2002. During the three months ended December 31, 2003 and
2002 the Company recorded net charge-offs totaling $160,000 and $405,000,
respectively. For more information on asset quality see "Asset Quality" in
Management's Discussion and Analysis of Financial Condition.
Noninterest Income. Noninterest income decreased by $414,000, or 16.8%, to $2.1
million for the three months ended December 31, 2003 from $2.5 million for the
three months ended December 31, 2002. The decrease in noninterest income was
largely due to decreases in fees and service charges and in gain on sale of
loans held for sale. Fees and service charge income decreased by $119,000, or
8.7%, to $1.3 million for the three months ended December 31, 2003, from $1.4
million for the three months ended December 31, 2002. In addition, gain on sale
of loans held for sale decreased by $79,000, or 47.6%, to $88,000 for the three
months ended December 31, 2003 from $167,000 for the three months ended December
31, 2002. The decreases in fees and service charge income and gain on sale of
loans resulted from slowing mortgage origination activity after an extended
period of low market interest rates. Real estate-related income generated by the
Company's subsidiaries was also affected by the slowdown in mortgage activity.
Income from real estate-related activities decreased by $69,000, or 17.3%, to
$327,000 for the three months ended December 31, 2003 from $396,000 for the
three months ended December 31, 2002. In addition, a loss of $19,000 on the sale
of real estate owned and held for development was recorded for the three months
ended December 31, 2003 as compared to a gain of $26,000 for the three months
ended December 31, 2002. Also, during the three months ended December 31, 2003
the Company recorded a loss on the sale of investment securities totaling
$33,000, while a gain on the sale of securities totaling $38,000 was recorded
for the three months ended December 31, 2002.
Noninterest expense. Partly offsetting the decrease in noninterest income was a
decrease in noninterest expense. Noninterest expense decreased by $288,000, or
6.1%, to $4.4 million for the three months ended December 31, 2003 from $4.7
million, for the three months ended December 31, 2002. The decrease in
noninterest expense was partly due to a decrease in amortization expense for
mortgage servicing assets. Such amortization expense totaled $90,000 for the
three months ended December 31, 2002, while no expense was recorded for the
three months ended December 31, 2003 since these assets had been fully
amortized. Advertising expense decreased by $59,000, or 40.2%, to $88,000 for
the three months ended December 31, 2003 from $147,000 for the three months
ended December 31, 2002. Also contributing to the decrease in noninterest
expense was a decrease in direct expenses related to mortgage production as
volume declined during the three months ended December 31, 2003. Staff
recruiting expenses and losses on the sale of repossessed vehicles also
decreased for the three months ended December 31, 2003 as compared to the three
months ended December 31, 2002.
17
Net earnings and income tax expense. Net earnings before income taxes decreased
by $253,000, or 10.8%, to $2.1 million for the three months ended December 31,
2003 from $2.3 million for the three months ended December 31, 2002. Income tax
expense totaled $673,000, or an effective tax rate of 32.2%, and $803,000, or an
effective tax rate of 34.3%, respectively, for the three months ended December
31, 2003 and 2002. The effective tax rate decreased for the three months ended
December 31, 2003 largely because tax-exempt income comprised a larger
percentage of pre-tax income for the three months ended December 31, 2003 than
for the three months ended December 31, 2002.
COMPARISON OF THE RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED December 31,
2003 and 2002
General. Net earnings for the six months ended December 31, 2003 increased by
$228,000, or 8.4%, to $3.0 million, or $0.79 per diluted share, from $2.7
million, or $0.67 per diluted share, for the six months ended December 31, 2002.
Interest Income. Interest income decreased by $2.9 million, or 15.6%, to $15.7
million for the six months ended December 31, 2003 from $18.6 million for the
six months ended December 31, 2002. The decrease in interest income was due to
decreases in both the average yield on interest-earning assets and in the
average balance of interest-earning assets. The average yield on
interest-earning assets decreased by 92 basis points to 5.62% for the six months
ended December 31, 2003 from 6.54% for the six months ended December 31, 2002,
due to changes in the mix of interest-earning assets and lower yields on all
categories of interest-earning assets in the continued low market interest rate
environment. In addition, the average balance of interest-earning assets
decreased by $8.9 million, or 1.6%, to $560.7 million for the six months ended
December 31, 2003 from $569.6 million for the six months ended December 31,
2002.
Interest income on loans receivable decreased by $1.8 million, or 11.5%, to
$13.6 million for the six months ended December 31, 2003 from $15.4 million for
the six months ended December 31, 2002. The decrease in interest income on loans
was primarily due to a decrease in the average yield on loans. The average yield
on loans receivable decreased by 128 basis points to 6.08% for the six months
ended December 31, 2003 from 7.36% for the six months ended December 31, 2002.
The decrease in the average yield on loans was due to refinancing activity and
to interest rate reductions for adjustable-rate loans in the generally lower
market interest rate environment during the current year period. Partially
offsetting the decrease in interest income due to lower yields was an increase
in the average balance of loans receivable. The average balance of loans
receivable increased by $27.8 million, or 6.6%, to $445.9 million for the six
months ended December 31, 2003 from $418.1 million for the six months ended
December 31, 2002. The increase in the average balance of loans receivable was
primarily funded by proceeds from the maturity and sale of investment
securities.
Interest income on investment securities decreased by $1.1 million, or 35.4%, to
$2.1 million for the six months ended December 31, 2003 from $3.2 million for
the six months ended December 31, 2002. The decrease in interest income on
investment securities was primarily due to a decrease in the average balance.
The average balance of investment securities decreased by $38.0 million, or
25.4% to $111.6 million for the six months ended December 31,
18
2003 from $149.6 million for the six months ended December 31, 2002. In
addition, the average tax-equivalent yield on investment securities decreased by
52 basis points to 3.95% for the six months ended December 31, 2003 from 4.47%
for the six months ended December 31, 2002 in the generally lower market
interest rate environment.
Interest Expense. Interest expense decreased by $2.2 million, or 25.0%, to $6.6
million for the six months ended December 31, 2003 from $8.8 million for the six
months ended December 31, 2002. The decrease in interest expense was primarily
due to a decrease in interest on deposits. Interest on deposits decreased by
$2.2 million, or 34.8%, to $4.0 million for the six months ended December 31,
2003 from $6.2 million for the six months ended December 31, 2002. The average
cost of deposits decreased by 88 basis points to 1.98% for the six months ended
December 31, 2003 from 2.86% for the six months ended December 31, 2002. The
decrease in the average cost of deposits was due to changes in the mix of
deposit types and to the generally lower market interest rate environment during
the six months ended December 31, 2003. Also contributing to the decrease in
interest on deposits was a decrease in the average balance of deposits. The
average balance of deposits decreased by $27.0 million, or 6.3%, to $405.8
million for the six months ended December 31, 2003 from $432.8 million for the
six months ended December 31, 2002. In addition, the Company lowered rates on
deposit products and increased its use of wholesale funding from the FHLB with
generally lower interest costs than term deposits.
Interest on FHLB advances and other borrowings totaled $2.5 million and $2.6
million, respectively, for the six months ended December 31, 2003 and 2002. The
average cost of borrowings decreased by 62 basis points to 4.22% for the six
months ended December 31, 2003 from 4.84% for the six months ended December 31,
2002. Offsetting the decrease in the average cost of borrowings was an increase
in the average balance of borrowings. The average balance of borrowings
increased by $13.1 million, or 12.3%, to $120.0 million for the six months ended
December 31, 2003 from $106.8 million for the six months ended December 31,
2002.
Net Interest Income. Net interest income before provision for losses on loans
decreased by $716,000, or 7.3%, to $9.1 million for the six months ended
December 31, 2003 from $9.9 million for the six months ended December 31, 2002
primarily due to a decrease in the Company's net interest margin. The Company's
net interest margin decreased by 15 basis points to 3.27% for the six months
ended December 31, 2003 from 3.42% for the six months ended December 31, 2002.
Provision for Losses on Loans. Provision for losses on loans totaled $625,000
and $1.2 million for the six months ended December 31, 2003 and 2002. During the
six months ended December 31, 2003 and 2002 the Company recorded net charge-offs
totaling $413,000 and $1.4 million, respectively. For more information on asset
quality see "Asset Quality" in Management's Discussion and Analysis of Financial
Condition.
Noninterest Income. Noninterest income decreased by $153,000, or 3.4%, to $4.4
million for the six months ended December 31, 2003 from $4.6 million for the six
months ended December 31, 2002. The decrease in noninterest income was largely
due to a net loss on sale of securities that totaled $65,000 for the six months
ended December 31, 2003. In comparison, the Company recorded a gain of $38,000
on the sale of securities for the six months ended December 31, 2002. In
addition, gain on sale of loans and gain on sale of real
19
estate owned and held for development decreased by $70,000 and $67,000,
respectively, for the six months ended December 31, 2003 as compared to the six
months ended December 31, 2002. Partially offsetting these decreases in
noninterest income was an increase in fees and service charges that totaled
$102,000 for the six months ended December 31, 2003 as compared to the six
months ended December 31, 2002. The increase in fees and service charges was
primarily due to an increase in overdraft activities on retail accounts and the
resulting service fees assessed. In addition, the restructuring of the Company's
checking and savings accounts included a more favorable service charge schedule.
Noninterest expense. More than offsetting the decrease in noninterest income was
a decrease in noninterest expense. Noninterest expense decreased by $559,000, or
6.2%, to $8.5 million for the six months ended December 31, 2003 from $9.1
million for the six months ended December 31, 2002 primarily due to a decrease
in other noninterest expense. The decrease in other noninterest expense was
partly due to a decrease in expense for the amortization of mortgage servicing
assets. Such amortization expense totaled $180,000 for the six months ended
December 31, 2002, while no expense was recorded for the six months ended
December 31, 2003 since these assets had been fully amortized. Other noninterest
expense also decreased due to a decrease of $94,000 in recruiting expense; a
decrease of $65,000 in per account service fee expense due to the elimination of
special features attached to eligible retail transaction accounts that had been
provided by a third party vendor; and, a decrease of $66,000 in loss on disposal
of repossessed assets for the six months ended December 31, 2003 as compared to
the six months ended December 31, 2002. In addition, advertising expense
decreased by $36,000, or 15.3%, to $200,000 for the six months ended December
31, 2003 from $236,000 for the six months ended December 31, 2002.
Net earnings and income tax expense. Net earnings before income taxes increased
by $295,000, or 7.2%, to $4.4 million for the six months ended December 31, 2003
from $4.1 million for the six months ended December 31, 2002. Income tax expense
totaled $1.5 million, or an effective tax rate of 33.1%, and $1.4 million, or an
effective tax rate of 33.8%, respectively, for the six months ended December 31,
2003 and 2002. The effective tax rate decreased for the six months ended
December 31, 2003 largely because tax-exempt income comprised a larger
percentage of pre-tax income for the six months ended December 31, 2003 than for
the six months ended December 31, 2002.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in market prices
and interest rates. The Company's market risk is primarily comprised of interest
rate risk resulting from its core banking activities of lending and deposit
taking. Interest rate risk is the risk that changes in market interest rates
might adversely affect the Company's net interest income or the economic value
of its portfolio of assets, liabilities and off-balance-sheet contracts.
Management continually develops and applies strategies to mitigate this risk.
The Company primarily relies on the OTS Net Portfolio Value Model (the "Model")
to measure its susceptibility to interest rate changes. For various assumed
hypothetical changes in market interest rates, the Model estimates the current
economic value of each type of asset, liability and off-balance-sheet contract.
The present value of expected net cash flows from existing assets minus the
present value of expected net cash flows from existing liabilities plus or minus
the present value of expected net cash flows from existing off-balance-sheet
contracts results in a net portfolio value ("NPV") estimate. An analysis of the
changes in NPV in the event of hypothetical changes in interest rates is
presented in the Form 10-K filed by the Company for the fiscal year ended June
30, 2003. Management does not believe that the Company has experienced any
material changes in its market risk position from that disclosed in the
Company's 2003 Form 10-K Annual Report as of June 30, 2003 or that the Company's
primary market risk exposures and how those exposures were managed during the
three months ended December 31, 2003 changed significantly when compared to June
30, 2003. The Company's NPV ratio after a 200 basis point rate-shock was 6.54%
and 6.79%, respectively, at September 30, 2003 and June 30, 2003 as measured by
the OTS Model.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of the Company's management,
including its Chief Executive Officer and Chief Financial Officer, the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rules 13a-15(e)and 15d-15(e)under the
Exchange Act) as of the end of the period covered by this report. Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of the period covered by this report, the
Company's disclosure controls and procedures were effective to ensure that
information required to be disclosed in the reports that the Company files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange Commission's
rules and forms.
There has been no change in the Company's internal control over financial
reporting in connection with the quarterly evaluation that occurred during the
Company's last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
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PART II. OTHER INFORMATION
Item 1.Legal Proceedings
There are various claims and lawsuits in which the Registrant is
periodically involved incidental to the Registrant's business. In the opinion of
management, no material loss is expected from any of such pending claims or
lawsuits.
Item 4.Submission of Matters to a Vote of Security Holders
Submission of Matters to a Vote of Security Holders
The Company convened its 2003 Annual Meeting of Stockholders on October
30, 2003. At the meeting, the stockholders of the Company considered and voted
on the following proposals:
Ballot No. 1.
The election of Jon G. Cleghorn, Steven L. Opsal and David Van Engelenhoven,
each to serve as directors for terms of three years and until their successors
have been elected and qualified - The results of Ballot No. 1 are as follows:
For Withheld
--- --------
Jon G. Cleghorn 3,072,752 37,358
Steven L. Opsal 3,061,467 48,643
David Van Engelenhoven 3,061,191 48,919
Ballot No. 2.
The ratification of the appointment of McGladrey & Pullen, LLP as auditors for
the Company for the fiscal year ending June 30, 2004 - The results of Ballot No.
2 are as follows:
For Against Abstain
--- ------- -------
Number of Votes 3,075,393 26,059 8,658
Percentage of total shares
voted at the Annual Meeting 98.9% 0.8% 0.3%
Ballot No. 3.
The amendment of the Company's 1999 Stock Option Plan to revise the provisions
relating to the vesting of options pursuant to such plan - The results of Ballot
No. 3 are as follows:
For Against Abstain
--- ------- -------
Number of Votes 1,897,971 286,059 47,822
Percentage of total shares
voted at the Annual Meeting 61.0% 9.2% 1.5%
Ballot No. 4.
The amendment of the Company's 1999 Recognition and Retention Plan to revise the
provisions relating to the vesting of awards pursuant to such plan - The results
of Ballot No. 4 are as follows:
For Against Abstain
--- ------- -------
Number of Votes 1,932,650 250,466 48,971
Percentage of total shares
voted at the Annual Meeting 62.1% 8.1% 1.6%
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Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 31.1 Certification of Chief Executive Officer
Pursuant to Section 302
Exhibit 31.2 Certification of Chief Financial Officer
Pursuant to Section 302
Exhibit 32 Statement Pursuant to Section 906
(b) Reports on Form 8-K
Reports on Form 8-K/A were filed on October 6, 2003 and October 8, 2003
pertaining to the same event. The event reported was the change in the
Registrant's certifying accountant.
A report on Form 8-K was filed on November 4, 2003. The event reported was the
Registrant's announcement of its Annual Shareholder Meeting results in a press
release dated October 30, 2003.
A report on Form 8-K and a subsequent report on Form 8-K/A were filed on
November 5, 2003 and November 6, 2003, respectively. The event reported was the
Company's announcement of quarterly results for the period ended September 30,
2003 in a press release dated October 31, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed by the undersigned thereunto
duly authorized.
FIRST FEDERAL BANKSHARES, INC.
DATE: February 13, 2004 BY: /s/ Barry E. Backhaus
---------------------
Barry E. Backhaus
President and
Chief Executive Officer
DATE: February 13, 2004 BY: /s/ Colin D. Anderson
---------------------
Colin D. Anderson
Senior Vice President and
Chief Financial Officer
24